Leases/Pensions

Question 1

Operating lease

Answer 1

An operating lease is essentially a rental arrangement. No asset or liability is reported by the lessee and the periodic lease payments are simply recognized as rental expense in the income statement.

Question 2

Finance lease

Answer 2

A finance lease is a purchase of an asset that is financed with debt. At the inception of the lease, the lessee will add equal amounts to both assets and liabilities on the balance sheet. Over the term of the lease, the lessee will recognize depreciation expense on the asset and interest expense on the liability.

Question 3

lessor

Answer 3

owner of the asset

Question 4

Operating lease (reporting by the lessee)

Answer 4

At the inception of the lease, the balance sheet is unaffected. No asset or liability is reported by the lessee.

During the term of the lease, rent expense equal to the lease payment is recognized in the lessee’s income statement.

In the cash flow statement, the lease payment is reported as an outflow from operating activities.

With an operating lease, the entire lease payment is an operating expense,

Question 5

Finance lease (reporting by the lessee)

Answer 5

At the inception of the lease, the lower of the present value of future minimum lease payments or the fair value of the leased asset is recognized as both an asset and as a liability on the lessee’s balance sheet. Over the term of the lease, the asset is depreciated in the income statement and interest expense is recognized. Interest expense is equal to the lease liability at the beginning of the period multiplied by the lease interest rate.

Income statement. Operating income (EBIT) will be higher for companies that use finance leases relative to companies that use operating leases.

Question 6

Financial statement of lease accounting

Answer 6

Question 7

Ratio impact of lease accounting

Answer 7

Question 8

defined benefit plan

Answer 8

In a defined benefit plan, the firm promises to make periodic payments to employees after retirement. The benefit is usually based on the employee’s years of service and the employee’s compensation at, or near, retirement.

Because the employee’s future benefit is defined, the employer assumes the investment risk.

Question 9

defined contribution plan

Answer 9

A defined contribution plan is a retirement plan in which the firm contributes a sum each period to the employee’s retirement account. The firm’s contribution can be based on any number of factors, including years of service, the employee’s age, compensation, profitability, or even a percentage of the employee’s contribution. In any event, the firm makes no promise to the employee regarding the future value of the plan assets.

The investment decisions are left to the employee, who assumes all of the investment risk.